In my previous column, we started looking at loan programs, with conventional mortgages getting the first introduction. This month, I’m going to cover another common type of mortgage, the Federal Housing Administration (FHA) loan. One of the main differences between an FHA and a conventional mortgage is that the FHA loan is secured by a government agency – the Federal Housing Administration. The FHA insures mortgages made by private lenders for single family homes and some other types of properties. Only FHA-approved lenders can originate FHA loans, so if you’re looking into an FHA loan, make sure your lender is approved to originate these types of mortgages.
FHA loans have several other main differences from a conventional mortgage:
- FHA loans allow for lower credit scores, and sometimes for a given credit score, the monthly mortgage insurance may be lower for an FHA loan than it may be for a conventional mortgage. The minimum down payment is also different than it is for a conventional loan. For credit scores of 580 and higher, the minimum down payment is 3.5% of the purchase price or appraised value, whichever is lower. For credit scores between 500 and 579, the minimum down payment is 10%. By comparison, borrowers need a credit score of at least 620 and a minimum down payment of between 3% and 20% to qualify for a conventional mortgage.
- The loan limit for FHA is governed by property location, with the standard loan limit for 2021 being $356,362. In higher cost areas of the country, the maximum loan limit can be as much as $822,375. A few special exemption areas also exist, namely Alaska, Hawaii, Guam and the U.S. Virgin Islands, where even higher limits may exist.
- There are fewer limitations about where “gift funds” can come from with an FHA loan. For a conventional loan, gift funds must come from a relative such as spouse, child, or other dependents, by any other individual who is related to the borrower by blood, marriage, adoption, legal guardianship, a domestic partner, or someone to whom you are engaged to be married. For an FHA loan, all the above are allowed but also the borrowers employer or labor union, a close friend with documented interest in the borrower, a charitable organization, or a governmental agency providing assistance to low- or moderate-income families, may also provide gift funds.
- Most FHA loans have an upfront mortgage insurance premium (UFMIP) that can either be paid at closing or financed into the loan amount. This premium is generally 1.75% of the loan amount.
- In addition to the UFMIP, FHA loans have monthly mortgage insurance premiums. The premium amount and length of time borrowers are required to pay this premium varies depending on the loan amount, term and loan-to-value (LTV) ratio but at a minimum, borrowers will pay monthly mortgage insurance for 11 years and could potentially be required to pay it for the entire mortgage term.
Of course, there are employment and income requirements that must be met to qualify for FHA loans as well for a conventional loan. The FHA doesn’t generally insure investment properties either. FHA loans are geared towards a principal residence that the owner intends to occupy. The property must be appraised by an FHA-approved appraiser and it must meet minimum standards set by the FHA.
An FHA loan can be a great option for a borrower with a credit score that may not otherwise qualify for a conventional loan. It may also afford the opportunity to obtain a mortgage and then work to improve one’s credit scores. With a higher score, a homeowner with an FHA loan may then be able to refinance into a conventional mortgage which if originated at 80% or less LTV, will not require mortgage insurance. There is no one-size-fits-all for mortgages, which is why you should always discuss your specific situation with a trusted mortgage lender. They will be able to review your application and supporting documents to help guide you to the most-suitable loan program for you.